ELECTRICITY MARKET DESIGN William W. Hogan Mossavar-Rahmani Center - PowerPoint PPT Presentation

ELECTRICITY MARKET DESIGN William W. Hogan Mossavar-Rahmani Center for Business and Government John F. Kennedy School of Government Harvard University Cambridge, Massachusetts 02138 Successes, Failures and Where We Go Next 150th New England Electricity Restructuring Roundtable May 18, 2016

ELECTRICITY MARKET Electricity Restructuring The early discussion of the immediate problems in the electricity industry was disjointed and focused in the perceived pieces of the solution rather than the larger puzzle. The traditional model and even the meaning of the word would have to change. This Puzzle Has No Solution t n e m n o r i v t n s o E C k y n r e u v S o c e R e t a i d s e e m c m r i P I r n e o w i t o a L g l i b O o t n y o l i n p t c o p d i i u s S s s i i r m u s J n a r T s s e c c A g n n e p l i e O M e h S W D s G W E e c i o h C Policy Challenge: Create Options and Make Choices 1

ELECTRICITY MARKET Electricity Restructuring Developing a consistent policy for electricity restructuring depended on having a coherent market design. This puzzle has a solution, but some old ideas must be discarded and new components put in place. With the Right Choices, the Pieces Can Fit Together Regulation Sunk Obligation Incentive Reliable Jurisdiction Cost to Service Recovery Regulation Deliver Open New RTGs Transmission Electricity EWGs Plants Market Access Cost Product Pool Environment DSM Control Innovation Dispatch n o t i a g l i b Customer O Bilateral o t Supply y Efficient Spot l p p u S Competition e t a Direct i d e s Prices e m c Contracts m r i P Access Choice I r e w o Wheeling L Competition 2

ELECTRICITY MARKET Path Dependence The path to successful market design can be circuitous and costly. The FERC “reforms” in Order 890 illustrate “path dependence,” where the path chosen constrains the choices ahead. Early attempts with contract path, flowgate and zonal models led to design failures in PJM (`97), New England (`98), California (`99), and Texas (`03). Regional aggregation creates conflicts with system operations. Successful market design integrates the market with system operations. (Hogan, 2002) Paths to Successful Market Design SMD Organized Market CAISO Bilateral Schedules "Last at Difference in Nodal Prices 1999 License Plate Access Charges Balancing Resort" Market-Driven Investment 1997 Coordinated Spot Market 1998 Transmission Bid-Based, Security-Constrained, Economic Dispatch Rights with Nodal Prices 2003 Rules 890 Financial Transmission Rights Explode ATC (TCCs, FTRs, FCRs, CRRs, ...) Reform 888 Standardization ISO Transparency PX Zonal Contract "Simple, Path Quick" Flowgate TLR 3

ELECTRICITY MARKET Energy Market Design The U.S. experience illustrates successful market design and remaining challenges for both theory and implementation.  Design Principle: Integrate Market Design and System Operations Competitive Wholesale Electricity Market Structure Provide good short-run operating incentives. Support forward markets and long-run investments. Generation Genco Genco Genco ... Genco Genco Genco ... ...  Design Framework: Bid-Based, Security Regional Transmission Organization Constrained Economic Dispatch Transmission Regulated Poolco ... Gridco Gridco Locational Marginal Prices (LMP) with System Operator granularity to match system operations. Distribution Financial Transmission Rights (FTRs). Regulated Disco Disco Disco ... Disco Disco Disco ... ...  Design Implementation: Pricing Evolution ... ... Cust. Cust. Cust. Cust. Cust. Cust. Better scarcity pricing to support resource adequacy. Unit commitment and lumpy decisions with coordination, bid guarantees and uplift payments.  Design Challenge: Infrastructure Investment Hybrid models to accommodate both market-based and regulated transmission investments. Beneficiary-pays principle to support integration with rest of the market design. 4

ELECTRICITY MARKET A Consistent Framework The example of successful central coordination, CRT, Regional Transmission Organization (RTO) Millennium Order (Order 2000) Standard Market Design (SMD) Notice of Proposed Rulemaking (NOPR), “Successful Market Design” provides a workable market framework that is working in places like New York, PJM in the Mid-Atlantic Region, New England, the Midwest, California, SPP, and Texas. This efficient market design is under (constant) attack. POOLCO POOLCO The RTO NOPR Order SMD NOPR "Successful Market Design" Contains a Consistent Framework Bilateral Schedules Poolco…OPCO…ISO…IMO…Transco…RTO… at Difference in Nodal Prices ITP…WMP…: "A rose by any other name …" License Plate Access Charges Market-Driven Investment “Locational marginal pricing (LMP) is the Coordinated Spot Market electricity spot pricing model that serves as Bid-Based, the benchmark for market design – the Security-Constrained, textbook ideal that should be the target for Economic Dispatch with Nodal Prices policy makers. A trading arrangement based on LMP takes all relevant generation and transmission costs appropriately into account 07/05 Financial Transmission Rights 07/02 and hence supports optimal investments.” (TCCs, FTRs, FCRs, CRRs, ...) 12/99 (International Energy Agency, 2007) 5/99 This is the only model that can meet the tests of open access and non-discrimination. Anything that upsets this design will unravel the wholesale electricity market. The basic economic dispatch model accommodates the green energy agenda, as in the expanding California-Pacificorp Energy Imbalance Market (EIM). 5

ELECTRICITY MARKET The Last Should Be First All energy delivery takes place in the real-time market. Market participants will anticipate and make forward decisions based on expectations about real-time prices.  Real-Time Prices: In a market where participants have discretion, the most important prices are those in real-time. “Despite the fact that quantities traded in the balancing markets are generally small, the prevailing balancing prices, or real-time prices, may have a strong impact on prices in the wholesale electricity markets. … No generator would want to sell on the wholesale market at a price lower than the expected real-time price, and no consumer would want to buy on the wholesale market at a price higher than the expected real-time price. As a consequence, any distortions in the real-time prices may filter through to the wholesale electricity prices.” (Cervigni & Perekhodtsev, 2013)  Day-Ahead Prices: Commitment decisions made day-ahead will be affected by the design of day- ahead pricing rules, but the energy component of day-ahead prices will be dominated by expectations about real-time prices.  Forward Prices: Forward prices will look ahead to the real-time and day-ahead markets. Although forward prices are developed in advance, the last prices in real-time will drive the system.  Getting the Prices Right: The last should be first. The most important focus should be on the models for real-time prices. Only after everything that can be done has been done, would it make sense to focus on out-of-market payments and forward market rules. 6

ELECTRICITY MARKET ERCOT Scarcity Pricing ERCOT launched implementation of the ORDC in in 2014. The summer peak is the most important period. The first year results showed high availability of reserves and low reserve prices. The experience in 2015 illustrates the fundamental properties of the ORDC, and higher reserve prices. Source: Resmi Surendran, Analysis of Reserves and Prices, July 2, 2015-August 23: Hour Ending 17:00 , ERCOT TAC Presentation, August 27, 2015. 7